Ortho stocks may be vulnerable as job losses mount

Smith & Nephew's Peri-Loc Periarticular Locked Plating System in an undated image. Knee replacement surgery can cost an arm and a leg -- and can seem even more daunting during hard economic times.

CHICAGO (Reuters) - Knee replacement surgery can cost an arm and a leg -- and can seem even more daunting during hard economic times.

Sales of knee and hip implants in the lucrative U.S. market slowed in the first quarter amid an overall decline in elective surgery. Some analysts say the trend may continue as job losses mount, insurance policies disappear and post-employment health coverage expires.

And shares of orthopedic device makers, historically a safe haven during an economic downturn, may be vulnerable. Demand for such devices is expected to remain strong over the long term as baby boomers age, but signs of a short-term hiccup have emerged.

"Historically, these procedures haven't been affected by the economy. What has changed since the last big recession is that people's co-payments weren't as high as they are now. And I don't think there were as many uninsured," said Wachovia analyst Michael Matson.

"Given that the nature of this recession is different in that it's consumer-led rather than business-led, and given that insurance is disappearing, I'm concerned (orthopedic device makers) could have more economic exposure than people realize," he added

Without insurance, a new knee can be expensive. The average cost of a total knee replacement, excluding doctors' fees, was $31,000 in 2003, the latest year for which data are available, according to the U.S. Agency for Healthcare Research and Quality.

Dr. Mary O'Connor, an orthopedic surgeon at Mayo Clinic in Jacksonville, Florida, said her patients are more aware of out-of-pocket expenses and try to time elective procedures to minimize costs.

"If they're not miserable and they can delay surgery for three or six months, then they would do that," she said.

Elective surgery tends to trend up heading into recession because people realize their jobs are at risk; they rush to get medical attention paid for by insurance, said BMO Capital Markets analyst Joanne Wuensch.

Indeed, the 2007 fourth quarter produced an uptick in hip and knee replacements.

"If the economy continues to sputter, and unemployment rises, elective procedures will go down," Wuensch said. "That says nothing of the tough fourth-quarter comparisons the ortho companies now face."

Orthopedic device maker Zimmer Holdings Inc (ZMH.N) last week posted weaker-than-expected first-quarter sales of hip and knee implants.

"I don't think we're seeing fundamental impact," Zimmer Chief Executive David Dvorak told a conference call. "I suppose if there was a long-term and sustained economic downturn, that could have an impact, but we aren't seeing those signs in the core business."

Quarterly results from Zimmer rivals Stryker Corp (SYK.N), Smith & Nephew (SN.L) and Johnson & Johnson's (JNJ.N) DePuy unit also reflected slower growth in the reconstructive implant market. But a big slowdown in Stryker's hip sales was due mostly to the company's hip product recall.

"TOO EARLY TO TELL"

J&J Chief Financial Officer Dominic Caruso said last month it was too early to explain the slowdown in medical procedures, including orthopedic implants.

"We just saw a little bit slower procedure growth this quarter than we had seen in the first quarter of prior years," Caruso said. "So it's a little too early to tell."

Valuations of stocks in the orthopedics group look "reasonable, or if anything they're a little bit cheap," J.P. Morgan analyst Michael Weinstein said, adding he was skeptical that the economy will have a meaningful impact on the companies.

Zimmer -- whose shares are up 14 percent this year, compared with a 3 percent decline in the S&P 500 Index -- is the most vulnerable to a slowdown in hip and knee sales since the company has the greatest exposure, generating almost three-quarters of its revenue from the reconstructive joints.

"Procedures that are truly elective are slowing ... and to the degree orthopedic procedures are elective, there may have been an impact in the first quarter," Weinstein said. "It's unclear, but the market is assuming that (first-quarter slowdown) was a one-off, and we believe there will be a pick-up in the second quarter."

Tim Nelson, an analyst for FAF Advisors, an asset-management firm overseeing about $107 billion, expects the economy to have a moderate impact on demand for orthopedic devices.

"But it's only temporary," he said. "How long can you put off a bum knee? It's the deferral of demand rather than the elimination of demand."

(Additional reporting by Kim Dixon in Washington; editing by John Wallace)